![]() ![]() Without hedging, the investor is not exposed to currency risk. To understand more about this topic, please check out our risk calculator.Īs carry trade earns profits based on interest rate differentials, it does not make sense for the investor to hedge their currency risk as this will eat away the profits brought by executing the carry trade. Thus, this example's carry trade profit is $1.22.Īlthough carry trade seems like an easy way to earn profits by exploiting the difference in interest rates, this trading strategy also comes with some risks. The last step is to calculate the carry trade profit using the formula below:Ĭarry trade profit = amount invested × investment return The amount invested for our example is $1,000. The amount invested is the amount of money you have invested in executing the carry trade. Investment return = (1 + (lending rate − borrowing rate) × (1 + spot rate differential)) ^ (days / 360) − 1 The investment return can be calculated using the formula below: ![]() The days until trade settles is 180 days. The days until trade settles is the number of days calculated from when the trade is initiated to the day when the trade is settled. In our example, the spot rate differential is (0.83 − 0.85) / 0.85 = -2.35%.ĭetermine the number of days until the trade is settled. Spot rate differential = (settle exchange rate − initial exchange rate) / initial exchange rate The spot rate differential can be calculated using the formula below: Hence, the lending rate is 0.75% and the borrowing rate is 0.5%. Hence, the lending rate is the USD interest rate, and the borrowing rate is the GBP interest rate. Number of days until the trade is settled: 180 daysĭetermine the lending rate and borrowing rate.Īs USD has a higher interest rate, the carry trade will involve buying the USD and selling the GBP.Now, let's look at the example below to understand how a carry trade works in practice after understanding the carry trade definition.Īssuming Company Alpha has executed the carry trade (long USD and short GBP) with the following information:
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